Airline Operating Costs Dr. Peter Belobaba

Network, Fleet and Schedule

Strategic Planning

Module 12: 1 April 2015

Istanbul Technical University

Air Transportation Management

M.Sc. Program

2

Lecture Outline

Cost Categorization Schemes

Administrative cost allocation

Functional cost categories and typical breakdown

Flight Operating Costs

Comparisons across aircraft types

Total costs vs. unit costs

Comparisons across airlines

Impacts of stage length on unit costs

Unit Cost Trends

Fuel, labor and non-labor unit costs

Aircraft and Employee Productivity

3

US DOT Form 41 Database

Form 41 contains traffic, financial, and operating cost

data reported to the DOT by US Major airlines

Data is reported and published quarterly for most tables

Detail of reporting differs for different expense categories Aircraft operating expenses by aircraft type and region of operation

Other expenses more difficult to allocate by aircraft type

Cost categorization schemes differ, but all are

affected by accounting and allocation assumptions

Administrative cost categories – financial reports

Functional cost categories – airline cost and productivity

comparisons

4

Administrative Cost Breakdown US

Airlines 2013

Source: US DOT Form 41 Financial Reports

SALARIES_BENEFITS29.0%

MATERIALS_TOTAL37.1%

SERVICES_TOTAL15.9%

LANDING_FEES2.1%

RENTALS7.0%

DEPRECIATION4.7%

AMORTIZATION0.7%

OTHER3.5%

5

Functional Cost Categories

Aircraft operating costs

Expenses associated with flying aircraft, also referred to as “Direct Operating Costs” (DOC)

Aircraft servicing costs

Handling aircraft on the ground, includes landing fees

Traffic service costs

Processing passengers, baggage and cargo at airports

Passenger service costs

Meals, flight attendants, in-flight services

Promotion and Sales costs

Airline reservations and ticket offices, travel agency commissions

Other costs, including:

General and administrative expense Depreciation and amortization

6

Functional Cost Breakdown

US Airlines 2012

Source: US DOT Form 41 Financial Reports

AIRCRAFT OPERATIONS

61.4%

PASSENGER SERVICE

6.6%

AIRCRAFT SERVICE5.7%

TRAFFIC SERVICE10.1%

RESERVATIONS AND SALES4.8%

ADVERTISING0.9% GENERAL

ADMIN8.4%

DEPRECIATION AND AMORTIZATION

2.0%With high fuel

prices, total Aircraft

Operating Costs

sum to 61%

7

Typical Costs by Functional Category

Aircraft Operating Costs

Per Block Hour (for example, $4500 for 150-seat A320 in 2013)

Aircraft Servicing Costs

Per Aircraft Departure (average $1200)

Traffic Servicing Costs

Per Enplaned Passenger (average $20)

Passenger Servicing Costs

Per RPM (average $0.013)

Reservations and Sales Costs

% of Total Revenue (average 7%)

Other Indirect and System Overhead Costs

% of Total Operating Expense (average 12%)

8

“Back of the Envelope” Break Even Fare

Boston-Orlando A320 Flight 80% LF

AOC 3.0 block hours @ $4500 $ 13500

Aircraft Servicing (1 departure @ $1200) $ 1200

Traffic Servicing (120 pax @ $20) $ 2400

Pax Servicing (132000 RPM @ $0.013) $ 1716

System Overhead Costs (12% of sub-total) $ 2566

Sub-total $ 21382

Break Even Net Revenue per Pax (120) $ 178

Distribution and Sales Costs (7% of fare) $ 13

Break Even Average Fare $ 191

9

Airline Operating Cost Breakdown

Adapted from Form 41, used by Boeing, MIT (and

Aviation Daily) for more detailed comparisons

FLIGHT (DIRECT) OPERATING COSTS (DOC) = 50% All costs related to aircraft flying operations

Include pilots, fuel, maintenance, and aircraft ownership

GROUND OPERATING COSTS = 30% Servicing of passengers and aircraft at airport stations

Includes aircraft landing fees and reservations/sales charges

SYSTEM OPERATING COSTS = 20% Marketing, administrative and general overhead items

Includes in-flight services and ground equipment ownership

Percentages shown reflect historical “rules of

thumb”.

10

World Airline Operating Cost Breakdown

ICAO OPERATING COST CATEGORIES 1992 2002 2005

Direct Aircraft Operating Costs 44.0 49.1 54.0

Flight Operations (Total) 26.1 30.7 37.7

Flight Crew 7.2 9.0 7.8

Fuel and Oil 12.2 13.0 21.9

Other 6.7 8.7 8.0

Maintenance and Overhaul 10.9 11.3 10.2

Depreciation and Amortization 7.0 7.1 6.1

Indirect Operating Costs 56.0 50.9 46.0

User charges and station expenses (Total) 17.2 17.0 16.2

Landing and associated airport charges 3.9 4.0 3.8

Other 13.3 13.0 12.4

Passenger services 10.8 10.3 9.3

Ticketing, sales and promotion 16.4 10.7 9.1

General, administrative and other 11.6 12.9 11.4

Source: ICAO, Belobaba et al (2009)

11

Flight Operating Costs

Flight operating costs (FOC) by aircraft type:

Reflect an average allocation of system-wide costs per block

hour, as reported by airlines for each aircraft type

Can be affected by specific airline network or operational patterns

Collected by US DOT as Form 41 operating data from airlines

Typical breakdown of FOC for US carrier:

CREW: Pilot wages and benefits

FUEL: Easiest to allocate and most clearly variable cost

MAINTENANCE: Direct airframe and engine maintenance cost,

plus “burden” or overhead (hangars and spare parts inventory)

OWNERSHIP: Depreciation, leasing costs and insurance

12

Example: Airbus 320 (avg. 150 seats)

Costs per block-hour 2005 2007 2013

CREW $ 470 $ 454 $ 652

FUEL $1327 $1713 $2385

MAINTENANCE $ 524 $ 576 $ 716

OWNERSHIP $ 570 $ 570 $ 726

TOTAL FOC $2891 $3313 $4567

Based on reported average stage length and block-hr daily utilization (weighted averages):

Different stage lengths and utilization by different airlines result in substantial variations in block-hour costs for same aircraft type

Also, differences in crew (union contracts, seniority), maintenance (wage rates), and ownership costs (age of a/c)

Source: US DOT Form 41 Statistics

13

A320 Aircraft Operating Costs 2013 Form 41 System Data

CREW COST FUEL/OIL MAINTENANCE OWNERSHIP TOTAL AOC

UNITED $793 $2,407 $624 $1,079 $4,903

DELTA $964 $2,254 $916 $536 $4,670

US AIRWAYS $431 $2,375 $1,014 $686 $4,506

VIRGIN AMERICA $419 $2,476 $362 $1,163 $4,420

FRONTIER $449 $2,488 $477 $827 $4,241

JETBLUE $665 $2,417 $700 $451 $4,233

SPIRIT $518 $2,233 $381 $921 $4,053

LCCs report 2% to 17% lower AOC per block hour than NLCs

Source: US DOT Form 41 Statistics

14

Comparison of FOC Across Aircraft

Types

All else equal, larger aircraft should have higher flight

operating cost per hour, lower unit cost per ASM:

There exist some clear economies of aircraft size (e.g., two pilots

for 100 and 400 seat aircraft, although paid at different rates)

Also economies of stage length, as fixed costs of taxi, take-off

and landing are spread over longer flight distance

But, many other factors distort cost comparisons:

Pilots paid more for larger aircraft that fly international routes

Newer technology engines are more efficient, even on small

planes

Reported depreciation costs are subject to accounting

procedures

Aircraft utilization rates affect allocation of costs per block-hour

15

FOC Selected Aircraft Types 2013 Form 41 System Data

Aircraft

Type

Average

Seats

AOC/

Block-hr

AOC/

Seat-hr

Average

Stage

(mi.)

Utilization

(block-

hrs/day)

E190 100 $3,612 $36.12 599 9.4

737-700 139 $4,358 $30.63 762 10.1

A320 150 $4,479 $29.86 1181 11.5

757-200 177 $5,839 $32.99 1523 10.1

A330-200 272 $8,795 $32.33 3645 14.6

747-400 375 $15,153 $40.41 4861 11.4

16

Total Operating Costs vs. Unit Costs

Total operating costs increase with size of airline,

aircraft size and stage length

Increased output (ASMs) leads to higher total operating costs

Bigger aircraft cost more to operate (per block hour, per flight)

Longer stage length means more fuel burned, more pilot and

flight attendant hours

But, due to high fixed costs, airlines should have

economies of scale in unit costs (in theory):

Larger aircraft should have lower operating costs per seat and

per seat-mile (ASM)

Longer stage lengths should lead to lower unit costs

Larger airlines with bigger aircraft flying longer stage

lengths should have lowest unit costs.

17

Impacts of Stage Length on Unit Costs

Industry unit cost curve is downward sloping with

respect to the average stage length.

A large proportion of the overall cost base is fixed, at

least in the short-term

Ownership costs, maintenance and ground infrastructure,

reservations/sales and overhead

Contributing factors: With longer stage lengths

All fixed costs can be spread over more ASMs

Shorter turn times relative to block times allow greater aircraft and

crew utilization

Average block speed increases and fuel burn decreases with

more time spent at cruise altitude

Cycle-related maintenance requirements are reduced

18

2012 Unit Cost (CASK)

Selected Non-US Airlines

Source: Emirates Open Sky 2/14 , CAPA Data

19

CASM vs. Stage Length US Airlines 2013

AmericanDelta

United

US Airways

Southwest

jetBlueFrontier

Virgin America

Alaska

Hawaiian

Allegiant

8.00

9.00

10.00

11.00

12.00

13.00

14.00

15.00

500 700 900 1,100 1,300 1,500 1,700 1,900

CA

SM E

x Tr

ansp

ort

-Re

late

d (

Ce

nts

)

Average Total Fleet Stage Length (Miles)

Source: MIT Airline Data Project

20

CASM Breakdown

1 2 3 4 5

Transport Related

Total CASM

Fuel

Labor CASM

Non-labor CASM

CASM ex.

Transport and

Fuel

CASM can be broken down as follows:

Transport Related expenses excluded for comparisons

21

Fuel, Labor and Non-Labor Costs

Compare macro trends over time and across airlines

Fuel Costs have been increasing to over 30%

Most “variable cost”, typically driven by global oil prices and factors

outside of airline control

Labor Costs have been decreasing in share

With greater emphasis on cost re-structuring and increasing labor

productivity

Significant cost advantages for newer airlines and LCCs

Non-labor Costs represent structural differences

In networks, product mix and operations

22

Operating Cost Breakdown by Region

• Fuel component has increased for all regions, while labor

percentages have declined.

• Labor share dropped the most for North America airlines.

Source: IATA

23

US Airlines: Inflation Adjusted CASM*

Down 35% Since 1978

$0.00

$0.05

$0.10

$0.15

$0.20

Fuel Labor Non-Labor

* CASM excl. Transp. Related Expenses

Source: MIT US Airline Productivity Study, 2011

24

Inflation Adjusted Unit Costs –

Fuel, Labor, Non-Labor

Source: MIT US Airline Productivity Study, 2011

25

US Airlines Jet Fuel Prices 2000-2013

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180Ja

n-00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

USD

per

Bar

rel o

f Jet

Fue

l

Source: Airlines for America

26

Aircraft Productivity

Aircraft “utilization” measured in block-hours/day:

Block hours begin at door close (blocks away from wheels) to

door open (blocks under wheels)

Gate-to-gate time, including ground taxi times

Productivity measured in ASMs per aircraft per day:

= (# departures) X (average stage length) X (# seats)

Increased aircraft productivity achieved with:

More flight departures per day, either through shorter turnaround

(ground) times or off-peak departure times

Longer stage lengths (average stage length is positively

correlated with increased aircraft utilization = block hours per day)

More seats in same aircraft type (no first class seating and/or

tighter “seat pitch”)

27

8.00

8.50

9.00

9.50

10.00

10.50

11.00

11.50

12.00

12.50

13.00

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Ave

rage

Blo

ck H

ou

rs p

er

Air

craf

t p

er

Day

LCC

NLC Narrowbody

NLC Widebody

Aircraft Utilization Block Hours per Aircraft per Day

Source: MIT Airline Data Project

+33%

28

A320 Productivity Comparison 2013 Form 41 System Data

TOTAL AOC Stage Number Departures Block Hours ASMs AOC per

PER BLK-HR Length (mi) of Seats per Day per Day per Day ASM

UNITED $4,903 1165 142 4.6 10.2 760,666 $0.066

DELTA $4,670 888 150 5.3 9.6 702,985 $0.064

US AIRWAYS $4,506 1090 150 4.9 12.4 796,868 $0.070

VIRGIN AMERICA $4,420 1575 147 4.6 12.5 1,071,914 $0.052

FRONTIER $4,241 1057 168 5 10.1 894,791 $0.048

JETBLUE $4,233 1361 150 5.1 12.9 1,042,392 $0.052

SPIRIT $4,053 968 178 6.9 12.9 1,193,464 $0.044

LCCs generate 20-60% more output than NLCs with same aircraft type.

Source: US DOT Form 41 Statistics

29

Employee Productivity

Measured in ASMs per employee per period

As with aircraft, employee productivity should be

higher with:

Longer stage lengths (amount of aircraft and traffic servicing for

each flight departure not proportional to stage length)

Larger aircraft sizes (economies of scale in labor required per

seat for each flight departure)

Increased aircraft productivity due to shorter turnaround times

(more ASMs generated by aircraft contribute to positive employee

productivity measures)

Yet, network airlines with long stage lengths and

large aircraft have lower employee productivity rates

30

Labor Productivity: ASM/FTE up 108%

Over half of gain achieved since 2000

100

200

300

400

500

600

0.0

0.5

1.0

1.5

2.0

2.5

3.01

97

8

197

9

198

0

198

1

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

YE

3q

'10

Fu

ll T

ime

Em

plo

ye

es

(T

ho

us

an

ds

)

RP

Ms p

er

FT

E

FTEs RPMs per FTE ASMs per FTE

Source: MIT US Airline Productivity Study, 2011

31

NLC employment down by 36% since

2000, a loss of 150,000 jobs

Source: MIT Airline Data Project

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Full-

Tim

e E

mp

loye

e E

qu

ival

en

ts

NLC

LCC

32

Concluding Thoughts

Legacy carriers made dramatic progress in cost

cutting and productivity improvement 2001-2007

Labor and distribution costs saw biggest reductions

Productivity improvements through network shifts, work rules and

use of IT for passenger processing

Not much room for further cost reductions

Labor will push to recover wage and benefit concessions

Distribution costs can’t go much lower

Aging fleets will push up maintenance costs

Recent return to industry profitability has relied

heavily on demand growth and revenue generation

Capacity discipline – higher yields and higher load factors